Revise The CPI Basket And Incorporate Mortgage Interest Payments

Even as the debate over whether India should target CPI ex-food instead or overall CPI continues, a research report from the economic department of State Bank of India (SBI) feels that the argument that food inflation remains sticky but core inflation has moved down and hence it is better to target headline inflation excluding food is actually counterfactual. It is precisely that successful inflation targeting by RBI has anchored inflationary expectations and thus the spill-over from higher food to core. The more the RBI communicates that four per cent is the inflation target, the more will be the successful anchoring of inflation targeting. There is no doubt whatsoever that India’s tryst with inflation targeting has been largely successful. Although the potential benefits of IT adoption are clear, the empirical evidence on its impact on inflation performance supports that India had a largely successful inflation targeting regime. Compared to advanced economies like the US, Germany and France, India had one of the lowest deviations from its inflation target in the triennial average inflation from 2021-2024. One has to keep in mind that being a late entrant to the club of countries that have been practicing monetary policy making in an IT framework since the 1990s, India adopted the best practices and procedures for the decision making process.

And despite the challenges posed by global demand-supply imbalances due to ongoing geopolitical tensions, the country’s inflation rate has been within its target range of 2-6 per cent in FY24. It is pertinent to note that the effectiveness of monetary policy in India’s pre–inflation targeting regime had been constrained by several India specific factors that affected transmission of the policy impulses through the interest rate channel. Some of the major factors were: i) sustained fiscal dominance, ii) large informal sector and significant presence of informal finance, and iii) bank’s behaviour in pricing loan products. All these have now been addressed successfully through the assiduous efforts of the government, RBI and banks in unison in the last decade. Monetary and fiscal policy coordination has worked seamlessly, especially since the pandemic. Little wonder that the recent SBI report feels that the success of inflation targeting is largely a by-product of a vibrant financial ecosystem where the Centre, RBI and banks are working closely in ushering in market reform.

However, it is important that we also undertake reforms in data infrastructure for a bottom-up policy making. India’s IT framework, with a tolerance band of (plus-minus) two per cent, already has in-built characteristics of a ‘make up’ strategy. Structural changes – globalisation; e-commerce; climate change – may test this embedded flexibility. Experts are of the view that composition of CPI is a major factor and it affects the IT framework. Apart from an imminent revision that has eluded the CPI basket since 2012, it needs to be relooked and include mortgage interest payments.

The SBI report points out that the review of the inflation target in March 2025 in India will coincide with many other changes that are expected, including CPI base change, household consumer expenditure survey and census.